The search for the next ultimate growth stock sometimes takes us down long, strange, winding roads. Other times, it's as straightforward as Mom and apple pie. Today we're going down the latter path, sticking with the basics to cover what many consider to be the screen for finding Rule Breakers stocks: sales growth.
Obviously, I'm not talking about plain-vanilla sales growth. I'm talking about outrageous sales growth -- the kind of growth that boasts a deep voice and pumps iron at Muscle Beach.
Get big -- fast!
Rule Breaking businesses, you see, tend to grow really fast when their convention-busting products hit the market. Think of Intuitive Surgical (Nasdaq: ISRG ) and its da Vinci robot surgical system. Or Google (Nasdaq: GOOG ) and online advertising. Each has seen massive revenue growth and, as a result, has provided investors with spectacular stock market returns.
So, when our team of analysts embarks on the search for new Rule Breakers, we usually start with companies that have generated in excess of 100% average sales growth over the past three years. There are several tools that will help you reveal candidates that meet this criterion. Here at Fool HQ we tend to use Capital IQ, a highly useful product that allows you to screen for almost anything. (Seriously, we've tried.)
Capital IQ found 126 firms that met our criteria this time around. Some were frighteningly high, such as James River Group (Nasdaq: JRVR ) at -- wait for it -- 2,417.2%, which started from scratch in 2002. Others made the cut easily, but in less spectacular fashion, such as BioMed Realty Trust (NYSE: BMR ) at 174.0%. But three really stood out:
1. XM Satellite Radio (Nasdaq: XMSR )
Three-year-revenue CAGR: 176.3%
It has to be tough to be XM CEO Hugh Panero. Well, OK, not that tough. In December, he sold 413,334 shares for more than $11 million. That sounds bad, especially when Bloomberg writes that the sale accounted for 99% of his holdings. Not surprisingly, shareholder suits soon followed, and the stock, down 35% from the beginning of the year, is like a skunk in a theater: Investors are running for the exits.
All of this makes me wonder: Is XM -- gulp -- a value stock? No, really, I'm dead serious. Take the insider selling debacle. According to the most recent proxy statement, Panero beneficially owns -- mostly through stock options -- 1.4 million shares. Before the sale he held roughly 1.8 million shares in the same fashion. By my count, then, Panero sold about 22% of his holdings. No, that's not great either. But 99% was overstating it.
There's also the valuation. I recently did some calculations that pegged the 2016 value of the satellite radio business at $20.6 billion. If that estimate is even in the ballpark, and XM does no better than pull equal to rival Sirius with 50% of the market, the company could be worth north of $10 billion in 10 years. That's more than a double from today's prices. Isn't that worth something? (Disclaimer: It may not be if XM never turns a profit, but that's part of the fun of Rule Breaking investing.)
2. Baidu.com (Nasdaq: BIDU )
Three-year-revenue CAGR: 211.9%
Hello, Baidu. The wannabe Google of China has attracted more than its share of headlines here and elsewhere thanks to a blockbuster IPO. Sadly, it's been mostly downhill since. But that couldn't have been too hard to predict, could it? The stock surged more than 350% on its first day of trading, largely on the promise to be Google. News flash: It isn't.
Baidu is, however, a great growth story. Take yesterday's first quarter earnings report. Revenue was up 196.8% over last year's Q1. Net income increased more than 1,300%. No doubt, that's spectacular and may explain why the stock was up more than 35% today. There's definitely going to be volatility going forward, but today's price may look cheap if this torrid pace continues.
3. True Religion Apparel (Nasdaq: TRLG )
Three-year-revenue CAGR: 2,132.0%
Some stocks simply inspire faith. Take designer jeans maker True Religion, for example. Last week the company reported strong first-quarter earnings and button-busting margins that lead its industry. And yet the stock still trades for just 11.3 times forward earnings and sports a price-to-earnings-to-growth (PEG) ratio of just 0.56. Such numbers strike me as positively divine, particularly in light of this analysis completed by Foolish research analyst Joey Khattab.
Just the beginning
There are innumerable ways to scan the markets for ultimate growth stocks. I hope what's been laid bare here gives you a bit of a head start should you choose to take on the work for yourself.
Fool co-founder and fearless Rule Breakers team leader David Gardner has said that the businesses breaking the rules are those that are altering the economics of their industries. Most "Faker Breakers" will claim as much in a bevy of press releases, but the companies to watch out for will prove their worth through massive revenue growth. If you're seeking multibagger returns for your portfolio, find those companies first. You can do it yourself, or we can help you at Rule Breakersfree for 30 days. Our picks are walloping the S&P 500 by more than 17 percentage points to date.
But no matter how you find your outrageous growth stocks, once you find them, just don't look back.
This article was originally published on October 14, 2005. It has been updated.
Fool contributor Tim Beyers only breaks the rules in his portfolio. Wimp. Tim didn't own shares in any of the companies mentioned in this story at the time of publication. You can find out what is in his portfolio by checking Tim's Fool profile. XM Satellite Radio and Intuitive Surgical are Rule Breakers recommendations. The Motley Fool has an ironclad disclosure policy.